The City regulator yesterday opened consultations on proposed new rules to force investors in a derivative known as contracts for difference (CFDs) to reveal their interest in underlying company shares.

The move by the Financial Services Authority follows claims that some investors were using CFDs - instruments that give exposure to a share without having to own it - to build up hidden stakes in companies.

Large institutional shareholders fear that an activist investor such as a hedge fund could build up a large stake in a company through CFDs without it immediately coming to light in the market.

In 2006, for example, it emerged that investors who ultimately acquired Birmingham industrial repairs company Dowding & Mills had - totally lawfully - built up holdings of CFDs equivalent to nearly 20 per cent of the company's capital.

They closed out the interest and bought the underlying shares the day before an offer document was published. This was the first public disclosure of a substantial interest in the company.

The FSA said yesterday it is considering introducing a rule to force investors holding CFDs to disclose their holding publicly in some circumstances.

The issue is important because CFDs and related trades account for a significant part of activity in the overall market. About 30 per cent of equity trades in the UK are in some way driven by CFD transactions, the FSA said.

Trade groups such as the Association of British Insurers have said CFDs make ownership difficult to track because disclosure rules are less stringent than for the ownership of cash equities.

The FSA, which put forward two proposals, said market failures were not widespread but needed to be addressed.

The first would require disclosure by investors who control three per cent or more of a company's voting rights via CFDs - unless the CFD holder had said it could not exercise or seek to exercise voting rights and had no arrangements in place over the sale of the underlying shares.

This would mean most CFD positions would not need to be disclosed, the FSA said.

The second approach, which the FSA said was simpler but costlier to enforce would require CFD holders to disclose all interests of five per cent or more.

"This is not a clampdown on CFDs but a means, following extensive research, of addressing the concerns about their use on an undisclosed basis," FSA director of markets Sally Dewar said.

"While the behaviour that concerns us is not widespread, it is important enough to require a tightening of the existing regime to ensure fair and orderly markets."